What is Normal Costing?

Normal costing is used to derive the cost of a product. This approach applies actual direct
costs to a product, as well as a standard overhead rate. It includes the actual cost of
materials, the actual cost of labor, and a standard overhead rate that is applied using the
product's actual usage of whatever allocation base is being used (such as direct labor hours
or machine time).

If there is a difference between the standard overhead cost and the actual overhead cost,
you can either charge the difference to the cost of goods sold (for smaller variances) or
prorate the difference between the cost of goods sold and inventory.

When to Use Normal Costing

Normal costing is designed to yield product costs that do not contain the sudden cost spikes
that can occur when actual overhead costs are used; instead, it uses a smoother long-term
estimated overhead rate.

It is acceptable under the generally accepted accounting principles and international

financial reporting standards accounting frameworks to use normal costing to derive the
cost of a product for financial reporting purposes.

Normal Costing vs. Standard Costing

Normal costing varies from standard costing, in that standard costing uses entirely
predetermined costs for all aspects of a product, while normal costing uses actual costs for
the materials and labor components.

For a more accurate view of the direction in which product costs are headed, it is better to
use actual costs, since they match the current amount of actual overhead costs. Standard
costs are the least usable from a management perspective, since the costs used may not
equate to actual costs. The accuracy level of normal costs is between actual costs and
standard costs.